Rethinking growth through a Schumpeterian perspective

May 12, 2017
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From Eurozone’s slow recovery to centuries-old stagnation, and including the state of inequality worldwide. Philippe Aghion, French economist at the Collège de France, spoke about all of these subjects this last Wednesday, at the seminar “The challenges for Europe: dialogues with Jean-Paul Fitoussi”, set up by the LUISS School of European Political Economy (click here for the next events).

Schumpeter’s Intuitions

Aghion pointed out that at the origin of his studies on growth – initially conducted with his colleague Peter Howitt – there was a fundamental dissatisfaction for the classic Solow model that was popular among economists: “And it’s an elegant one, though it doesn’t tell us where technological progress would have come from”, Hence the idea of using some of the intuitions by Joseph Schumpeter (1883–1950): for example, the belief that long-term growth is driven by innovations; that innovations largely depend on entrepreneurs; and, finally the mechanism of “creative destruction” by which new innovations constantly replace older ones. Aghion has had the merit of transforming these same intuitions into an economical model that is empirically verifiable (here you can read of one of his largely considered “historical” papers).

The aforementioned empirical approach has led Aghion, among other things, to correct some paradoxical conclusions to which he would gotten to if propelled by theory alone. If growth means, to a company, winning a monopoly in a particular sector – the economist, has explained by way of example – it might follow that “competition is damaging to growth because it reduces the possibility of obtaining a monopoly, killing an incentive for enterprises ”; However, “real life and empirical studies such as those of economist Richard Blundell differ from theory, as they show that de facto innovation is only carried out by frontier companies (ie., the most advanced ones from a technological standpoint). Competition continues to have a positive effect on these border companies, while indeed the most traditional ones may be discouraged from moving away from the prospect of conquering some form of monopoly”.

Eurozone’s Slow Recovery

The division between operators on this technological border and those who are well far from it turns out to be useful, in Aghion’s studies, to reflect on the countries’ economic growth. The economist yesterday has referred to the case of the “middle income trap” which Argentina fell into in the 1930s, when the South American country stopped growing at the same rate of the United States, and he has compared that situation to the abrupt French slump in growth after The Glorious Thirty. “The more a country is developmentally behind, the more it will try to grow through imitation of the more advanced countries”, Aghion said. “But the layout of a country that’s suitable for an imitation process is not necessarily suitable for competition too”. France, to be perfectly clear, is struggling to reform itself, moving from a kind of institutions that performed well in the imitative development phase to a type of institutions that makes it possible for self-propelled development – that is, a country at the border of innovation. This difficulty, Aghion noted, is also due to the fact that during periods of imitative growth, some of the vested interests appropriate privileged positions that they then defend for decades with everything they have. So, in which direction should the advanced countries move today in order to increase their productivity? By liberalising the product market, investing massively on education and research, liberalising the labour market. These are issues, those outlined by Aghion, quoted as we speak by institutions such as the European Central Bank in its Economic Bulletin (see the mention on page 68).

Centuries-Old Stagnation? Too Much Pessimism

Aghion is less pessimistic than other economists when it comes to the hypothesis that advanced countries are knee-deep in a so-called “centuries-old stagnation”. “Firstly”, the economist said, quoting the studies by his colleague Dale Jorgenson, “the information revolution not only modifies the technologies used to manufacture the products, but also the ones with which we form ideas”. Strengthening the ways in which we interact and exchange ideas, in short, increases potential growth in a manner that’s difficult to predict. Secondly, according to Aghion, the pace of technological innovation generates a growth measurement problem – due precisely to the Schumpeterian process of “creative destruction” – which leads our statistics to increasingly underestimate GDP. Finally, can we really talk about “centuries-old stagnation” for a continent like Europe that is still “so far from its efficiency border”? The answer, for Aghion, is “no”. This is so because – as evidenced by the strong increase in the total productivity of factors in European countries that have embarked on profound reforms, as is the case with Sweden – the fact that the Old Continent grows at such a slow pace means that “we can do much better”.

Inequality? Keep An Eye On It, But Don’t Obsess On It

Finally, the Collège de France economist has hinted at his own research on wealth distribution. He noted, for instance, that income inequality has increased in recent years, but this is mainly due to those who have capitalized on innovation entering into the well-known “top 1%”, while the distribution in the remaining 99% of society goes essentially unchanged. “I’m not obsessed with the income of the 1% – Aghion said – Rather, I worry that this 1% can start fighting to prevent further competition”. However, he warned that he did not agree with those colleagues – such as Thomas Piketty – who lump together a millionaire like Carlos Slim, a Mexican tycoon who grew rich through assets privatization in his country, and someone like Steve Jobs (who made it big by creating Apple, that is through a new set of products and needs that did not even exist before him). Equal taxation with punitive intent for both forms of wealth would be unfair, as well as counterproductive, because it would “kill innovation, which instead features various positive consequences, including for example being positively correlated with social mobility.”